Unlocking Credit for Small US Businesses

What did the Obama Administration announce on 16 March 2009?

The Treasury Department will commit up to US$15bn to help unlock the secondary markets for small business loans. By purchasing these securities, the Treasury Department will facilitate the ability of lenders to make new loans to small businesses by providing confidence that there will be a ready buyer for those loans in the secondary market. In addition, the Small Business Administration (SBA) is immediately implementing two key provisions of the Recovery Act – temporarily eliminating certain loan fees and raising guarantee levels on some of its loans.

These steps will provide lenders with the security they need to start lending again to the millions of small business owners desperately in need of capital. Finally, the Treasury Department issued a call for new reporting requirements designed to better track small business lending by banks and unveiled guidance from the IRS for an expanded ‘carryback’ provision that will offer many small businesses a tax refund.

Why will purchasing securities on the secondary market help small business owners?

Under normal circumstances, many banks sell a portion of their loans to companies that pool them together and sell them as securities to investors. This provides banks with new capital that they can use to make additional loans. The result is that the secondary markets significantly increase the amount of lending banks can do to small businesses.

Over the past year, however, the secondary markets for 7(a) and first lien 504 securities have ground to a virtual halt. The institutions that securitise these loans have been unable to find buyers for the securities they have already packaged. This has in turn reduced their willingness to purchase new loans from banks. Since banks depend on the secondary markets for liquidity, they have increasingly become reluctant to extend credit to small businesses.

The recent announcement will help unlock secondary markets by providing assurances that the government will stand ready to purchase 7(a) and 504 first-lien securities. If you apply for a 7(a) or 504 loan at your local community bank, that bank will be more willing to lend because it will have confidence that the Treasury Department will be a ready buyer of the loan in the secondary markets.

Which loans are affected by the fee elimination and higher guarantees?

The SBA will temporarily raise guarantees and eliminate fees for borrowers on certain of its 7(a) loans. 7(a) loans, which are partially guaranteed by the SBA, are issued by a bank to a small business to support its operations. Additionally, the SBA has temporarily eliminated fees for borrowers and third party lenders on its 504 Certified Development Company Loans. These loans offer growing small businesses long-term, fixed-rate financing for major fixed assets, such as land, buildings and machinery and equipment. These loans are aimed at fostering community development, creating jobs and encouraging modernisation.

How do SMEs apply for these loans?

Borrowers apply for loans directly with their lending institutions, including banks, credit unions, and small business lending companies. The SBA works with thousands of small and large lenders nationwide. Lenders evaluate loan applications under their lending standards and decide whether to:

• Make the loan through conventional financing – without a SBA guarantee – because the borrower meets their conventional credit standards.
• Make the loan with a SBA guarantee if the borrower does not meet conventional standards and is eligible for SBA programmes.
• Decline to make the loan.

What kind of businesses typically get SBA-backed loans?

Typical 7(a) borrowers are entrepreneurs looking to start, expand or acquire a small business. In many cases, the applicant may have a strong business idea, management ability, and sound financial projections, but may have a shortfall in collateral to secure a loan or equity to put into the business. In order to qualify for a SBA 7(a) loan, borrowers must be unable to secure conventional commercial financing on reasonable terms and be a ‘small business’ as defined by SBA size standards. In 2008, of the US$18bn in SBA backed loans, 35% went to start-up businesses, nearly 32% (US$5.7bn) went to minority owned businesses, and nearly 23% went to women-owned businesses.

The most frequently financed industries in 2008 were services, retail trade, accommodation/food service, construction firms, and manufacturing. SBA-backed loans are three to five times more likely to be made to minority and women-owned businesses than conventional small business loans made by banks, according to a recent study by the Urban Institute.

Is there a limit on how much a company can apply for?

The maximum loan amount for a 7(a) loan is US$2m. For 504 loans, the loan structures and amounts vary since lenders and borrowers each determine how much equity they are putting into the loan. However, for the SBA portion of the loan, the maximum loan amount is either US$2m or US$4m, depending on the purpose of the loan. For most purposes, the SBA’s maximum guarantee for any borrower remains at US$1.5m, or 75% of a US$2m loan.

Is the elimination of borrower fees permanent and retroactive?

The temporary fee eliminations for 7(a) loans support an overall programme level of US$8.7bn, while the temporary fee eliminations for 504 loans support an overall programme level of US$3.6bn. Depending on loan volume in these programmes, the SBA estimates that it will be able to eliminate these fees on loans approved through approximately 31 December 2009. Fee eliminations will be retroactive for all eligible loans approved on or after 17 February 2009.

What kind of savings is seen from the temporary borrower fee elimination?

Fees for a 7(a) loan are based only on the guaranteed portion of the loan and depend on the size of the loan. The fees range from 2% to 3.75%. For example, a US$300,000 loan with a 75% guaranty would have a guarantee fee of 3%. With the temporary elimination of fees, you would save US$6,750.00 (US$300,000 x 75% x 3%). Under the new 90% guaranty your savings would be US$8,100 (US$300,000 x 90% x 3%).

As a small business owner – what does the 90% guarantee mean?

It means that the lender will have less risk and a greater sense of security due to the higher guarantee percentage and will be more likely to extend credit to your small business.

Can I go to any lender in my area to take advantage of these new programmes?

Only lenders who have been approved to participate in SBA lending programmes can assist you with an SBA-guaranteed loan. Contact your local SBA District Office to obtain a list of approved participants in your area. Follow this link to locate the District Office nearest you: https://www.sba.gov/localresources/index.html.

What if my company was already turned down by a bank in the past six months? Can I qualify for any of these new programmes?

You are eligible to apply, but you will need to provide updated financial information that is current within 90 days. Over the past year the financial position of many individuals and businesses has deteriorated along with the economy, making some unfortunately no longer creditworthy.

The banks aren’t lending to me. So how do any of the programmes the President announced help me?

Revisit your lender and specifically ask about the Recovery Act and SBA loans. Many of the provisions in the Act provide incentives to lenders to encourage them to start lending again to get more dollars in the hands of the small businesses that need it most. Banks will now have access to more funds and higher guarantees making it less risky and more attractive to lend to small businesses. Also, you can contact your local SBA District Office to obtain a list of SBA-participating lenders in your area.

I have only been in business for two years and don’t have three years of financial statements or business history. Can I get a loan?

Yes, you may qualify for a loan. SBA loan guarantee programmes are available to start-up, newly established and growing businesses. You will need to provide whatever financial information you have available and will also be asked to furnish financial projections with assumptions to support your loan request.

I need working capital now to buy inventory and to make payroll. How long will it take to get a loan? How much can I apply for?

You can apply for a loan by talking to a local SBA participating lender today. Once SBA receives a complete application package from your lender, SBA typically responds to the lender within a few business days. SBA loan programmes are available for most sound business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements, and debt refinancing (under special conditions). The maximum loan size under SBA’s 7(a) loan programme is US$2m although some programmes have specific maximums that are lower.

The President mentioned that the US$15bn from the Treasury would primarily be focused on buying loans and freeing up lending for community banks, credit unions and other small lenders. Why?

Community banks, credit unions and other small lenders account for about 40% of all SBA-backed loans. Unclogging the secondary market for these local, small lenders will help them provide greater access to capital for the small businesses and entrepreneurs in their communities. While unclogging the secondary market is aimed at providing a funding source for smaller lenders, large lenders may also use the secondary market as a source of liquidity.